UNIT 4: MUTUAL FUNDS AND OTHER SERVICES

• Mutual Funds
Introduction, Types of Mutual funds, Organisation of mutual funds,
Regulation of mutual funds, brief introduction of SEBI regulations.
• Leasing & Hire Purchase
Concept of leasing, types of leasing, concept of Hire purchase, legal
aspects of HP, financial evaluation of HP.
 MUTUAL FUND:
1.1 INTRODUCTION:
• A Mutual Fund is a trust that pools the savings of a number of investors who share a common
financial goal. Anybody with an investible surplus of as little as a few hundred rupees can invest in Mutual
Funds. These investors buy units of a particular Mutual Fund scheme that has a defined investment
objective and strategy.
• The money thus collected is then invested
by the fund manager in different types of
securities.
• These could range from shares to
debentures to money market instruments,
depending upon the scheme’s stated objectives.
The income earned through these investments and
the capital appreciation realized by the scheme is
shared by its unit in proportion to the number of
units owned by them.
• Thus a Mutual Fund is the most suitable
investment for the common man as it offers an
opportunity to invest in a diversified,
professionally managed basket of securities at a
relatively low- cost.
• Mutual fund is a vehicle to mobilize money from investors, to invest in different markets and securities,
in line with the investment objectives agreed upon, between the mutual fund and the investors. In other
words, through investment in a mutual fund, an investor can get access to markets that may otherwise be
unavailable to them and avail of the professional fund management services offered by an asset
management company.
• As per SEBI: Mutual fund is a mechanism for pooling the resources by issuing units to the
investors and investing funds in securities in accordance with objectives as disclosed in offer document.
• SEBI (Mutual Fund) Regulations, 1996 as amended till date define “mutual fund” as “a fund
established in the form of a trust to raise monies through the sale of units to the public or a section of the
public under one or more schemes for investing in securities including money market instruments or gold
or gold-related instruments or real estate assets.”
• Investments in securities are spread across a wide cross-section of industries and sectors and thus
the risk is reduced. Diversification reduces the risk because all stocks may not move in the same direction
in the same proportion at the same time. Mutual fund issues units to the investors in accordance with
quantum of money invested by them. Investors of mutual funds are known as unit holders.
• The profits or losses are shared by the investors in proportion to their investments. The mutual
 funds normally come out with a number of schemes with different investment objectives which are
launched from time to time. A mutual fund is required to be registered with Securities and Exchange
Board of India (SEBI) which regulates securities markets before it can collect funds from the public.

• As per AMFI: A mutual fund is a pool of money managed by a professional Fund Manager. It is a
trust that collects money from a number of investors who share a common investment objective and
invests the same in equities, bonds, money market instruments and/or other securities. And the income /
gains generated from this collective investment is distributed proportionately amongst the investors after
deducting applicable expenses and levies, by calculating a scheme’s “Net Asset Value” or NAV. Simply
put, the money pooled in by a large number of investors is what makes up a Mutual Fund.

1.2 TYPES OF FUNDS/CLASSIFICATION OF FUNDS:

In the investment market, one can find a variety of investors with different needs, objectives and risk-
taking capacities. For instance, a young businessman would like to get more capital appreciation for this
funds and he would be prepare to take greater risks than a person who is just on the verge of this retiring
age. So, it is very difficult to offer one fund to satisfy all the requirements of investors. Just as one shoe
is not suitable for all legs, one fund is not suitable to meet the vast requirements of all investors. Therefore,
many types of funds are available to the investor. It is completely left to the discretion of the investor to
choose any one of them depending upon his requirement and his risk-taking capacity.
Mutual fund scheme can broadly be classified into many types as given in the chart given below:

Open Ended Actively Debt

Managed Infrastucture
Clode Ended Equity Real Estate Commodity International FoF ETF
Interval Passive Hybrid

1.2.1 OPEN-ENDED FUNDS, CLOSE-ENDED FUNDS AND INTERVAL FUNDS:

(A) Close-ended funds: The corpus of the fund and its duration are prefixed in advance. Once the
subscription reaches the predetermined level, the entryof investors is closed. After the expiry of the fixed
period, the entire corpus is disinvested and the proceeds are distributed to the various unit holders in
proportion to their holding.
Features: The main features of the close-ended funds are
i.The period and / or the target amount of the fund is definite and fixed beforehand. ii.Once the period
is over and / or the target is reached, the door is closed for the
investors. They cannot purchase any more units.
iii. These units are publicly traded through stock exchange and generally, there is no repurchase facility by
 the fund.
iv. The main objective of this fund is capital appreciation.
v. The whole fund is available for the entire duration of the scheme and there will not be any redemption
demands before its maturity. Hence, the fund manager can manage the investment efficiently and
profitably without the necessity of maintaining and liquidity.
vi. At the time of redemption, the entire investment pertaining to a close-ended scheme is liquidated and the
proceeds are distributed among the unit holders.
vii. From the investor’s point of view, it may attract more tax since the entire capital appreciation in the
value of the investment.
viii. If the market condition is not favourable, it may also affect the investor since he may not get the full
benefit of capital appreciation in the value of the investment.

(B) Open-ended funds: It is the opposite of close-ended funds. Under this scheme, the size of the
fund and / or the period of the fund are not predetermined. The investors are free to buy and sell any
number of units at any point of time. For instance, the Unit Scheme (1964) of the Unit Trust of India is
an open ended one, both in terms of period and target amount. Anybody can buy this unit at any time
and sell it also at any time at his discretion.
Features: The main features of the open-ended funds are
i. There is complete flexibility with regard to one’s investment or disinvestment. In other words, there is
free entry and exit of investors in an open-ended fund. There is no time limit. The investors can join in
and come out from the fund as and when he desires.
ii. This unit are not publicly traded but, the fund is ready to repurchase them and resell them at any time.
iii. The investor is offered instant liquidity in the sense that the units can be sold on any working day. In
fact, the fund operates just like a bank account, where in one can get cash across the counter for any
number of units sold.
iv. The main objective of this fund is income generation. The investors get dividend, rights or bonuses as
rewards for their investment.
v. Since the units are not listed on the stock market, their prices are linked to the Net Asset Value (NAV)
of the units. The NAV is determined by the fund and it varies from time-to-time.
vi. Generally, the listed prices are very close to their Net Asset Value. The fund fixes a different price for
their purchases and sales.
vii. The fund manager has to be very careful in managing the investments because he has to meet the
redemption demands at any time made during the life of thescheme.

(C) Interval Schemes:

Interval funds combine features of both open-ended and close-ended schemes. They are largely
close-ended, but become open-ended at pre-specified intervals. For instance, an interval scheme might
become open-ended between January 1 to 15, and July 1 to 15, each year. The benefit for investors is
that, unlike in a purely close- ended scheme, they are not completely dependent on the stock exchange
to be able to buy or sell units of the interval fund. However, between these intervals, the units have to be
compulsorily listed on stock exchanges to allow investors an exit route.
The periods when an interval scheme becomes open-ended, are called ‘transaction periods’; the
period between the close of a transaction period, and the opening of the next transaction period is called
‘interval period’. Minimum duration of transaction period is 2 days, and minimum duration of interval
period is 15 days. No redemption/repurchase of units is allowed except during the specified transaction
period (during which both subscription and redemption may be made to and from the scheme).

1.2.2 ACTIVELY MANAGED FUNDS AND PASSIVE FUNDS:

Actively managed funds are funds where the fund manager has the flexibility to choose the
investment portfolio, within the broad parameters of the investment objective of the scheme. Since this
increases the role of the fund manager, the expenses for running the fund turn out to be higher. Investors
expect actively managed funds to perform better than the market.
Passive funds invest on the basis of a specified index, whose performance it seeks to track. Thus,
a passive fund tracking the S&P BSE SENSEX would buy only the shares that are part of the composition
of the S&P BSE SENSEX. The proportion of each share in the scheme’s portfolio would also be the
same as the weightage assigned to the share in the computation of the S&P BSE SENSEX. Thus, the
performance of these funds tends to mirror the concerned index. They are not designed to perform better
than the market. Such schemes are also called index schemes. Since the portfolio is determined by the index
itself, the fund manager has no role in deciding on investments. Therefore, these schemes have low running
costs.
Exchange Traded Funds (ETFs) are also passive funds whose portfolio replicates an index or
benchmark such as an equity market index or a commodity index. The units are issued to the investors
in a new fund offer (NFO) after which they are available for sale and purchase on a stock exchange.
Units are credited to the investor’s demat account and the transactions post-NFO is done through the
trading and settlement platforms of the stock exchange. The units of the ETF are traded at real time prices
that are linked to the changes in the underlying index.

1.2.3 DEBT, EQUITY AND HYBRID FUNDS:

The portfolio of a mutual fund scheme will be driven by the stated investment objective of the
scheme. A scheme might have an investment portfolio invested largely in equity shares and equity-
related investments such as convertible debentures. The investment objective of such funds is to seek
capital appreciation through investment in these growth assets. Such schemes are called equity schemes.
Schemes with an investment objective that limits them to investments in debt securities such as
Treasury Bills, Government Securities, Bonds and Debentures are called debt funds.
Hybrid funds have an investment charter that provides for investment in both debt and equity. Some
of them invest in gold along with either debt or equity or both.
Other funds, such as Gold funds, Real estate funds, Commodity funds and International funds,
create portfolios that reflect their investment objectives.

1.2.3.1 TYPES OF DEBT FUNDS:

 Debt funds can be categorized on the basis of the type of debt securities they invest in. The
distinction can be primarily on the basis of the tenor of the securities— short term or long term, and the
issuer: government, corporate, PSUs and others. The risk and return of the securities will vary based on
the tenor and issuer. The strategy adopted by the fund manager to create and manage the portfolio can
also be a factor for categorizing debt funds.

1.2.3.1.1 On the basis of Issuer:

Gilt funds invest in only treasury bills and government securities, which do not have a credit risk
(i.e. the risk that the issuer of the security defaults). These securities pay a lower coupon or interest to
reflect the low risk of default associated with them. Long-term gilt funds invest in government securities
of medium and long-term maturities. There is no risk of default and liquidity is considerably higher in
case of government securities. However, prices of long-term government securities are very sensitive to
interest rate changes.
Corporate bond funds invest in debt securities issued by companies, including PSUs. There is a
credit risk associated with the issuer that is denoted by the credit rating assigned to the security. Such
bonds pay a higher coupon income to compensate for the credit risk associated with them. The prices of
corporate bondsare also sensitive to interest rate changes depending upon the tenor of the securities held.

1.2.3.1.2 On the basis of Tenor:

Liquid schemes or money market schemes are a variant of debt schemes that invest only in short
term debt securities. They can invest in debt securities of upto 91 days maturity. However, securities in
the portfolio having maturity of more than 60- days need to be valued at market prices [“marked to
market” (MTM)]. Since MTM contributes to volatility of NAV, fund managers of liquid schemes prefer
to keep most of their portfolio in debt securities of less than 60-day maturity. As will be seen later in this
workbook, this helps in positioning liquid schemes as the lowest in price risk among all kinds of mutual
fund schemes. Therefore, these schemes are ideal for investors seeking high liquidity with safety of capital.
Short term debt schemes invest in securities with short tenors that have low interest rate risk of
significant changes in the value of the securities. Ultra-short term debt funds, short-term debt funds,
short-term gilt funds are some of the funds in this category. The contribution of interest income and the
gain/loss in the value of the securities and the volatility in the returns from the fund will vary depending
upon the tenor of the securities included in the portfolio.
Ultra short-term plans are also known as treasury management funds, or cash management funds.
They invest in money market and other short term securities of maturity upto 365 days. The objective is
to generate a steady return, mostly coming from accrual of interest income, with minimal NAV volatility.
Short Term Plans combines short term debt securities with a small allocation to longer term debt
securities. Short term plans earn interest from short term securities and interest and capital gains from
long term securities. Fund managers take a call on the exposure to long term securities based on their
view for interest rate movements. If interest rates are expected to go down, these funds increase their
exposure to long term securities to benefit from the resultant increase in prices. The volatility in returns
will depend upon the extent of long-term debt securities in the portfolio.
 Long-term debt schemes such as Gilt funds and Income funds invest in longer- term securities
issued by the government and other corporate issuers. The returns from these schemes are significantly
impacted by changes in the value of the securities and therefore see greater volatility in the returns.

1.2.3.1.3 On the basis of Investment Strategy:

Diversified debt funds or Income fund, invest in a mix of government and non-government debt
securities such as corporate bonds, debentures and commercial paper. The corporate bonds earn higher
coupon income on account of the credit risks associated with them. The government securities are held
to meet liquidity needs and to exploit opportunities to capital gains arising from interest rate movements.
Junk bond schemes or high yield bond schemes invest in securities that have a lower credit rating
indicating poor credit quality. Such schemes operate on the premise that the attractive returns offered by
the investee companies makes up for the losses arising out of a few companies defaulting.
Dynamic debt funds are flexible in terms of the type of debt securities held and their tenors. They
do not focus on long or short term securities or any particular category of issuer but look for opportunities
to earn income and capital gains across segments of the debt market. Duration of these portfolios are not
fixed, but are dynamically managed. If the manager believes that interest rates could move up, the
duration of the portfolio is reduced and vice versa.
Fixed maturity plans are a kind of debt fund where the duration of the investment portfolio is
closely aligned to the maturity of the scheme. AMCs tend to structure the scheme around pre-identified
investments. Further, being close-ended schemes, they do not accept money post-NFO, therefore, the
fund manager has little ongoing role in deciding on the investment options. Portfolio construction gives
more clarity to investors on the likely returns if they stay invested in the scheme until its maturity (though
there can be no guarantee or assurance of such returns). This helps them compare the returns with
alternative investments like bank deposits.
Floating rate funds invest largely in floating rate debt securities i.e. debt securities where the
interest rate payable by the issuer changes in line with the market. For example, a debt security where
interest payable is described as ‘5-year Government Security yield plus 1 percent’, will pay interest rate
of 7 percent, when the 5-year Government Security yield is 6 percent; if 5-year Government Security yield
goes down to 3 percent, then only 4 percent interest will be payable on that debt security. The NAVs of such
schemes fluctuate lesser than other debt funds that invest more in debt securities offering a fixed rate of
interest.

1.2.3.2 TYPES OF EQUITY FUNDS:

• Equity funds invest in equity instruments issued by companies. The funds target long-term
appreciation in the value of the portfolio from the gains in the value of the securities held and the
dividends earned on it. The securities in the portfolio are typically listed on the stock exchange, and the
changes in the price of the securities are reflected in the volatile returns from the portfolio. These funds
can be categorized based on the type of equity shares that are included in the portfolio and the strategy
or style adopted by the fund manager to pick the securities and manage the portfolio.
• Diversified equity fund is a category of funds that invest in a diverse mix of securities that cut
across sectors and market capitalization. The risk of the fund’s performance being significantly affected
by the poor performance of one sector or segment is low.
• Market Segment based funds invest in companies of a particular market size. Equity stocks may
be segmented based on market capitalization as large- cap, mid- cap and small-cap stocks.
1. Large- cap funds invest in stocks of large, liquid blue-chip companies with stable performance and
returns.
2. Mid-cap funds invest in mid-cap companies that have the potential for faster growth and higher
returns. These companies are more susceptible to economic downturns. Therefore, evaluating and
selecting the right companies becomes important. Funds that invest in such companies have a higher
risk, since the selected e companies may not being able to withstand the slowdown in revenues and
profits. Similarly, the price of the stocks also fall more when markets fall.
3. Small-cap funds invest in companies with small market capitalisation with intent of benefitting
from the higher gains in the price of stocks. The risks are also higher.
• Sector funds invest in only a specific sector. For example, a banking sector fund will invest in only
shares of banking companies. Gold sector fund will invest in only shares of gold-related companies. The
performance of such funds can see periods of under-performance and out-performance as it is linked to
the performance of the sector, which tends to be cyclical. Entry and exit into these funds need to be timed
well so that the investor does not invest when the sector has peaked and exit when the sector performance
falls. This makes the scheme more risky than a diversified equity scheme.
• Thematic funds invest in line with an investment theme. For example, an infrastructure thematic
fund might invest in shares of companies that are into infrastructure construction, infrastructure toll-
collection, cement, steel, telecom, power etc. The investment is thus more broad-based than a sector
fund; but narrower than a diversified equity fund and still has the risk of concentration.
• Strategy-based Schemes have portfolios that are created and managed according to a stated style
or strategy. Equity Income/Dividend Yield Schemes investin securities whose shares fluctuate less, and
the dividend represents a larger proportion of the returns on those shares. They represent companies with
stable earnings but not many opportunities for growth or expansion. The NAV of such equity schemes
are expected to fluctuate lesser than other categories of equity schemes. Value fund invest in shares of
fundamentally strong companies that are currently under-valued in the market with the expectation of
benefiting from an increase in price as the market recognizes the true value. Such funds have lower
risk. They require a longer investment horizon for the strategy to play out. Growth Funds portfolios feature
companies whose earnings are expected to grow at a rate higher than the average rate. These funds aim at
providing capital appreciation to the investors and provide above average returns in bullish markets. The
volatility in returns is higher in such funds. Focused funds hold portfolios concentrated in a limited number
of stocks. Selection risks are high in such funds. If the fund manager selects the right stocks then the strategy
pays off. If even a few of the stocks do not perform as expected the impact on the scheme’s returns can be
significant as they constitute a large part of the portfolio.
• Equity Linked Savings Schemes (ELSS) are diversified equity funds that offer tax benefits to
investors under section 80 C of the Income Tax Act up to an investment limit of Rs. 150,000 a year. ELSS
are required to hold at least 80 percent of its portfolio in equity instruments. The investment is subject to
lock-in for a period of 3 years during which it cannot be redeemed, transferred or pledged. However, this
is subject to change in case there are any amendments in the ELSS Guidelines with respect to the lock-
in period.
• Rajiv Gandhi Equity Savings Schemes (RGESS) too, as seen earlier, offer tax benefits to first-
time investors (direct equity). Investments are subject to a fixed lock-in period of 1 year, and flexible
lock-in period of 2 years.

1.2.3.3 TYPES OF HYBRID FUNDS:

• Hybrid funds invest in a combination of asset classes such as equity, debt and gold. The
combination of asset classes used will depend upon the investment objective of the fund. The risk and
return in the scheme will depend upon the allocation to each asset class and the type of securities in each
asset class that are included in the portfolio. The risk is higher if the equity component is higher.
Similarly, the risk is higher if the debt component is invested in longer-term debt securities or lower rated
instruments.
• Debt-oriented Hybrid funds invest primarily in debt with a small allocation to equity. The equity
allocation can range from 5 percent to 30 percent and is stated in the offer document. The debt component
is conservatively managed to earn coupon income, while the equity component provides the booster to
the returns.
• Monthly Income Plan is a type of debt-oriented hybrid fund that seeks to declare a dividend every
month. There is no guarantee that a dividend will be paid each month. The term ‘Monthly Income’ is a
bit of a misnomer and investor needs to study the scheme properly, before presuming that an income will
be received every month.
• Multiple Yield Funds generate returns over the medium term with exposure to multiple asset
classes, such as equity and debt.
• Equity-oriented Hybrid funds invest primarily in equity, with a portion of the portfolio invested in
debt to bring stability to the returns. A very popular category among the equity-oriented hybrid funds is
the Balanced Fund. These schemes provide investors simultaneous exposure to both equity and debt in
one portfolio. The objective of these schemes is to provide growth and stability (or regular income), where
investments in equity instruments are made to meet the objective of growth while debt investments are
made to achieve the objective of stability. The balanced funds can have fixed or flexible allocation
between equity and debt. One can get the information about the allocation and investment style from the
Scheme Information Document.
• Capital Protected Schemes are close-ended schemes, which are structured to ensure that investors
get their principal back, irrespective of what happens to the market. This is ideally done by investing in
Zero Coupon Government Securities whose maturity is aligned to the scheme’s maturity. (Zero coupon
securities are securities that do not pay a regular interest, but accumulate the interest, and pay it along
with the principal when the security matures).
• As detailed in the following example, the investment is structured, such that the principal amount
invested in the zero-coupon security, together with the interest that accumulates during the period of the
scheme would grow to the amount that the investor invested at the start.
• Suppose an investor invested Rs. 10,000 in a capital protected scheme of 5 years. If 5-year
government securities yield 7 percent at that time, then an amount of Rs. 7,129.86 invested in 5 -year
zero-coupon government securities would mature to Rs. 10,000 in 5 years. Thus, by investing Rs.
7,129.86 in the 5-year zero-coupon government security, the scheme ensures that it will have Rs 10,000
to repay to the investor in 5 years. After investing in the government security, Rs 2,870.14 is left over
(Rs. 10,000 invested by the investor, less Rs. 7129.86 invested in government securities). This amount
is invested in riskier securities like equities. Even if the risky investment becomes completely worthless
(a rare possibility), the investor is assured of getting back the principal invested, out of the maturity
money received on the government security.
• Some of these schemes are structured with a minor difference – the investment is made in good
quality debt securities issued by companies, rather than Central Government Securities. Since any
borrower other than the government can default, it would be appropriate to view these alternate structures
as Capital Protection Oriented Schemes rather than Capital Protected Schemes. It may be noted that
capital protection can also be offered through a guarantee from a guarantor, who has the financial strength
to offer the guarantee. Such schemes are however not prevalent in the market. Some of the hybrid funds
are also launched as Asset Allocation Funds. These funds do not specify a minimum or maximum limit
for each of the asset classes. The fund manager allocates resources based on the expected performance
of each asset class.
• Arbitrage funds take opposite positions in different markets / securities, such that the risk is
neutralized, but a return is earned. For instance, by buying a share in BSE, and simultaneously selling
the same share in the NSE at a higher price. Most arbitrage funds take contrary positions between the
equity market and the futures and options market. (‘Futures’ and ‘Options’ are commonly referred to as
derivatives. These are designed to help investors to take positions or protect their risk in some other
security, such as an equity share. They are traded in exchanges like the NSE and the BSE). Although
these schemes invest in equity markets, the expected returns are in line with liquid funds.

1.2.4 REAL ESTATE MUTUAL FUND SCHEMES / REAL ESTATE INVESTMENT TRUSTS:
• Real Estate Mutual Funds scheme means a mutual fund scheme that invests directly or indirectly
in real estate assets or other permissible assets in accordance with the SEBI (Mutual Funds) Regulations,
1996. SEBI’s regulations require that at least 35 percent of the portfolio should be held in physical assets.
Not less than 75 percent of the net assets of the scheme shall be in real estate assets, mortgage-backed
securities (but not directly in mortgages), equity shares or debentures of companies engaged in dealing
in real estate assets or in undertaking real estate development project. Assets held by the fund will be
valued every 90 days by two valuers accredited by a credit rating agency. The lower of the two values
will be taken to calculate the NAV. These funds are closed-end funds and have to be listed on a stock
exchange.
 • Real Estate Investment Trusts (REIT) are trusts registered with SEBI that invest in commercial
real estate assets. The REIT will raise funds through an initial offer and subsequently through follow-on
offers, rights issue and institutional placements. The value of the assets owned or proposed to be owned
by a REIT coming out with an initial offer will not be less than Rs. 500 crore and the minimum offer
size will not be less than Rs.250 crore. The minimum subscription amount in an initial offer shall be Rs. 2
lakh. The units will be listed on the stock exchange.

1.2.5 COMMODITY FUNDS:

Commodities, as an asset class, include:
• Food crops like wheat andgram
• Spices like pepper andturmeric
• Fibres like cotton
• Industrial metals like copper and aluminium
• Energy products like oil and natural gas
• Precious metals (bullion) like gold and silver
The investment objective of commodity funds would specify which of these
commodities it proposes to invest in.
• Gold Funds: These funds invest in gold and gold-related securities. They canbe structured in either
of the following formats:
• Gold Exchange Traded fund, which is like an index fund that invests in gold, gold receipts or gold
deposit schemes of banks. Each ETF unit typically representsone gram of gold. For every unit of ETF
issued, the fund holds gold in the form of physical gold of 99.5 percent purity or gold receipts. They are
also allowed to invest in the gold deposit schemes of banks to a limit of 20 percent of the net assets of
the scheme. The NAV of such funds moves in line with gold prices in the market.
• Gold funds invest in the units of Gold Exchange Traded Funds. They operate just like other mutual
funds as far as the investor is concerned.
• Gold Sector fund will invest in shares of companies engaged in gold mining and processing.
Though gold prices influence these shares, the prices of these shares are more closely linked to the
profitability and gold reserves of the companies. Therefore, NAV of these funds do not closely mirror
gold prices. As with gold, such funds can be structured as Commodity ETF or Commodity Sector Funds.
In India, mutual fund schemes are not permitted to invest in commodities, other than Gold. Therefore,
the commodity funds in the market are in the nature of Commodity Sector Funds, i.e. funds that invest
in shares of companies that are into commodities. Like Gold Sector Funds, Commodity Sector Funds too
are a kind of equity fund.

1.2.6 INTERNATIONAL FUNDS:

• International funds invest in markets outside India, by holding certain foreign securities in their
portfolio. The eligible securities in Indian international funds include equity shares of companies listed
abroad; ADRs and GDRs of Indian companies, debt of companies listed abroad, ETFs of other countries,
units of index funds in other countries, units of actively managed mutual funds in other countries.
International equity funds may also hold some of their portfolios in Indian equity or debt. They can also
hold some portion of the portfolio in money market instruments to manage liquidity. One way for the
fund to manage the investment is to hire the requisite people who will manage the fund. Since their
salaries would add to the fixed costs of managing the fund, it can be justified only if a large corpus of
funds is available for such investment.
• An alternative route would be to tie up with a foreign fund (called the hostfund). If an Indian mutual
fund sees potential in China, it will tie up with a Chinese fund. In India, it will launch what is called a
feeder fund. Investors in India will invest in the feeder fund. The money collected in the feeder fund
would be invested in the Chinese host fund. Thus, when the Chinese market does well, the Chinese host
fund would do well, and the feeder fund in India will follow suit. Such feeder funds can be used for any
kind of international investment, subject to the scheme objective. The investment could be specific to a
country (like the China fund) or diversified across countries. A feeder fund can be aligned to any host
fund with any investment objective in any part of the world, subject to legal restrictions of India and the
other country. In such schemes, the local investors invest in rupees for buying the Units. The rupees are
converted into foreign currency for investing abroad. They need to be re-convertedinto rupees when the
money is to be paid back to the local investors. Since the future foreign currency rates cannot be predicted
today, there is an element of foreign currency risk. Investor's total return in such schemes will depend on how
the international investment performs, as well as how the foreign currency performs. Weakness in the foreign
currency can pull down the investors' overall return. Similarly, appreciation in the respective currency will
boost the portfolio performance.

1.2.7 FUND OF FUNDS (FOF):

• A Fund of Funds (FoF) is a mutual fund that invests in other mutual funds. It does not hold securities
in its portfolio, but other funds that have been chosen to match its investment objective. These funds can
be either debt or equity, depending on the objective of the FoF. A Fund of Funds either invests in other
mutual funds belonging to the same fund house or belonging to other fund houses. FoFs belonging to
various mutual fund houses are called multi-manager FoFs, because the AMCs that manage the funds are
different. Fund of Funds looks for funds that fit into its investment objective. It specialises in analyzing
funds, their performance and strategy and adds or removes funds based on such analysis. A FoF imposes
additional cost on the investor, as the expenses of the underlying funds are built into their NAV.

1.2.8 EXCHANGE TRADED FUNDS:

• Exchange Traded funds (ETF) are open-ended funds, whose units are traded in a stock exchange.
Investors buy units directly from the mutual fund only during the NFO of the scheme. All further purchase
and sale transactions in the units are conducted on the stock exchange where the units are listed. The
mutual fund issues further units and redeems units directly only in large lots defined as creation units.
Transactions in ETF units on the stock exchange happen at market-determined prices. In order to
facilitate such transactions in the stock market, the mutual fund appoints intermediaries called authorized
dealers as market makers, whose job is to offer a price quote for buying and selling units at all times. A
higher demand for units can push the price of the units higher than the NAV and a lower demand can
 push down the prices. The authorized dealers can make more units available in the market to meet the
higher demand by getting units released by the mutual fund in creation units. They have to submit the
underlying assets or cash equivalent with the mutual fund for this. Similarly, they can reduce the available
units available in the market by getting units redeemed in creation units.
• The major advantage of the market makers is to provide liquidity in the units of the ETFs to the
investors. In a regular open-ended mutual fund, all the purchases of units by investors on a day happen
at a single price. Similarly, all the sales of units by investors on a day happen at a single price. The
securities market however keeps fluctuating during the day. A key benefit of an ETF is that investors
can buy and sell their units in the stock exchange, at real-time prices during the day that closely track
the market at that time. This transaction price may be close to the NAV, but not necessarily the same as
NAV. Further, the unique structure of ETFs, make them more cost-effective than normal index funds,
although the investor would bear a brokerage cost when he transacts with the market maker and need to
have a demat accountinto which the units of the ETF will be credited.
1.2.9 INFRASTRUCTURE DEBT SCHEMES:
• These are closed-ended schemes with a tenor of at least five years that invest in debt securities and
securitized debt of infrastructure companies. 90 percent of the fund’s portfolio should be invested in the
specified securities. The remaining can be invested in the equity shares of infrastructure companies and
in money market instruments. The NAV of the scheme will be disclosed at least once each quarter. The
minimum investment allowed in these schemes is for Rs. 1 crore and the minimum face value of each unit
shall be Rs. 10 lakh. As a closed-ended scheme theunits of the scheme will be listed on a stock exchange. An
Infrastructure Debt Scheme can be set up by an existing mutual fund or a new fund set up for this purpose.
The sponsor and key personnel must have adequate experience in the infrastructure sector to be able to
launch the scheme. Infrastructure Investment Trusts (InvIT) are trusts registered with SEBI that invest in
the infrastructure sector. The InvIT will raise funds from the public through an initial offer of units. The offer
shall be for not less than Rs. 250 crores and the value of the proposed assets of the InvIT shall not be less
than Rs. 500 crores. The minimum subscription size will be Rs. 10 lakh. The units will be listed on a stock
exchange.

EXAMPLE OF MUTUAL FUND:

 ICICI Prudential Focused Bluechip Equity Fund (G)
1.3 ORGANIZATION OF MUTUAL FUNDS:
1.3.1 LEGAL STRUCTURE OF MUTUAL FUNDS IN INDIA:
SEBI (Mutual Fund) Regulations, 1996 as amended till date define “mutual fund” as “a fund established
in the form of a trust to raise monies through the sale of units to the public or a section of the public
under one or more schemes for investing in securities including money market instruments or gold or
gold-related instruments or real estate assets.”
Key features of a mutual fund that flows from the definition above are:
It is established as a trust
It raises money through sale of units to the public or a section of the public
The units are sold under one or more schemes
The schemes invest in securities (including money market instruments) or gold or gold-related
instruments or real estate assets.
SEBI has stipulated the legal structure under which mutual funds in India need to be constituted. The
structure, which has inherent checks and balances to protect the interests of the investors, can be briefly
described as follows:
 Mutual funds are constituted as Trusts. Therefore, they are governed by the Indian Trusts Act,
1882.
The mutual fund trust is created by one or more Sponsors, who are the main persons behind the
mutual fund business.
Every trust has beneficiaries. The beneficiaries, in the case of a mutual fund trust, are the investors
who invest in various schemes of the mutual fund.
The operations of the mutual fund trust are governed by a Trust Deed, which is executed between
the sponsors and the trustees. SEBI has laid down various clauses that need to be part of the Trust Deed.
The Trust acts through its trustees. Therefore, the role of protecting the interests of the beneficiaries
(investors) is that of the Trustees. The first trustees are named in the Trust Deed, which also prescribes
the procedure for change in Trustees.
In order to perform the trusteeship role, either individuals may be appointed as trustees or a Trustee
company may be appointed. When individuals are appointed trustees, they are jointly referred to as
‘Board of Trustees’. A trustee company functions through its Board of Director s.
Day to day management of the schemes is handled by an Asset Management Company (AMC).
The AMC is appointed by the sponsor or the Trustees.
The trustees execute an investment management agreement with the AMC, setting out its
responsibilities.
Although the AMC manages the schemes, custody of the assets of the scheme (securities, gold,
gold-related instruments & real estate assets) is with a Custodian, who is appointed by the Trustees.
Investors invest in various schemes of the mutual fund. The record of investors and their unit-
holding may be maintained by the AMC itself, or it can appoint a Registrar & Transfer Agent (RTA).
Let us understand the various agencies, by taking the example of the constitution of SBI Mutual Fund.

Mutual Fund Trust SBI Mutual Fund

Sponsor State Bank of India
Trustee SBI Mutual Fund Trustee Company Private Limited
AMC SBI Funds Management Private Limited
Custodian HDFC Bank Limited
SBI-SG Global Securities Services Private Limited Bank of
Nova Scotia (custodian for Gold)
RTA Computer Age Management Services Pvt. Ltd
1.3.2 KEY CONSTITUENTS OF A MUTUAL FUND:
1.3.2.1 Sponsors
The application to SEBI for registration of a mutual fund is made by the sponsor/s. Thereafter, the sponsor
invests in the capital of the AMC.
Since sponsors are the main people behind the mutual fund operation, eligibility criteria has been specified
as follows:
The sponsor should have a sound track record and reputation of fairness and integrity in all business
transactions. The requirements are:
✓ Sponsor should be carrying on business in financial services for not less than 5 years.
✓ Sponsor should have positive net worth (share capital plus reserves minus accumulated losses) in
all the immediately preceding 5 years.
✓ Net worth in the immediately preceding year should be more than the amount that the sponsor
contributes to the capital of the AMC.
✓ The sponsor should have earned profits, after providing for depreciation and interest and tax, in
three of the previous five years, including the latest year.
The sponsor should be a fit and proper person for this kind of operation.
The sponsor needs to contribute a minimum 40 percent of the net worth of the AMC. Further,
anyone who holds 40 percent or more of the net worth of share-holding in the AMC is considered to be
a sponsor, and should therefore fulfill the eligibility criteria mentioned above.
Sponsors have to contribute a minimum of Rs.1,00,000 as initial contribution to the corpus of the
mutual fund.
In the example of SBI Mutual Fund cited above, the sponsor is State Bank of India, an Indian public sector
bank. Sponsorship may be institutional (LIC Nomura Mutual Fund), entirely foreign (like Franklin
Templeton Mutual Fund and Goldman Sachs Mutual Fund), predominantly foreign joint venture (like JP
Morgan Mutual Fund & HSBC Mutual Fund) or predominantly Indian joint venture (like Birla Sun Life
Mutual Fund & ICICI Prudential Mutual Fund).

1.3.2.2 Trustee
The trustees have a critical role in ensuring that the mutual fund complies with all the regulations, and
protects the interests of the unit-holders.
The SEBI Regulations stipulate that:
Every trustee has to be a person of ability, integrity and standing.
A person who is guilty of moral turpitude cannot be appointed trustee.
A person convicted of any economic offence or violation of any securities laws cannot be appointed
as trustee.
No AMC and no director (including independent director), officer, employee of an AMC shall be
eligible to be appointed as a trustee of a mutual fund.
No person who is appointed as a trustee of a mutual fund shall be eligible to be appointed as trustee
of any other mutual fund.
Prior approval of SEBI needs to be taken, before a person is appointed as Trustee.
The sponsor will have to appoint at least 4 trustees. If a trustee company has been appointed, then that
company would need to have at least 4 directors on the Board. Further, at least two-thirds of the trustees
/ directors on the Board of the trustee company would need to be independent trustees i.e. not associated
with the sponsor in any way.
SEBI expects Trustees to perform a key role in ensuring legal compliances and protecting the interest of
investors. Accordingly, various General Due Diligence and Special Due Diligence responsibilities have
been assigned to them. The rights and responsibilities include the following:
Enter into an Investment Management Agreement with the AMC that will define the functioning
of the AMC in making and managing the mutual fund’s investments.
The trustees have the right to seek any information they require from the AMC to facilitate meeting
their responsibilities as trustees.

The trustees shall ensure before the launch of any scheme that all the key personnel and associates
such as fund managers, compliance officer, R&T agent, auditors and others have been appointed and all
systems are inplace.
The trustees shall periodically review the service contracts entered into for custody arrangements,
transfer agency and others and ensure they are in the interest of the unitholders and that all service
providers are registered with SEBI.
They shall ensure that all transactions entered into by the AMC are in compliance with the
regulations and the scheme’s objectives and intent.
The trustees shall ensure that the interests of the unitholders are not compromised in any of the
AMC’s dealings with brokers, other associates and even unitholders of other schemes.
If the trustees believe that the conduct of the business of the mutual fund is contrary to the
provisions of the regulations, then they must take corrective action and inform SEBI of the same.
The trustees shall not permit a change in the fundamental attributes of the scheme, the trust or fees
and expenses or any other change that will affect the interests of the unit holders unless a written
communication is sent to each unitholder, a notice is given in the newspaper with national circulation
and the unitholders are given the option to exit at NAV without paying an exit load.
Trustees have to file details of their securities dealings on a quarterly basis with the mutual fund.
On a quarterly basis the trustees shall review the transactions of the mutual fund with the AMC and
its associates. They shall also review the net worth of the AMC on a quarterly basis and ensure that any
shortfall is made up.
The trustees shall periodically review the investor complaints received and their redressal by the
AMC.
They shall ensure that the trust property is properly protected, held and administered.
The trustees shall obtain and consider the reports of the auditors and compliance officers in their
periodic meetings and take action as required.
Make half-yearly reports to SEBI
The strict provisions go a long way in promoting the independence of the role of trusteeship in a mutual
fund.

1.3.2.3 Asset Management Company (AMC)

Day to day operations of asset management is handled by the AMC. The sponsor or, the trustees if so
authorized by the trust deed, shall appoint the AMC with the approval of SEBI.
As per SEBI regulations:
The directors of the asset management company need to be persons having adequate professional
experience in finance and financial services relatedfield.
The directors as well as key personnel of the AMC should not have been found guilty of moral
turpitude or convicted of any economic offence or violation of any securities laws.
Key personnel of the AMC should not have worked for any asset management company or mutual
fund or any intermediary during the period when its registration was suspended or cancelled at any time
by SEBI.
Prior approval of the trustees is required, before a person is appointed as director on the board of
the AMC.
Further, at least 50 percent of the directors should be independent directors i.e. not associate of or
associated with the sponsor or any of its subsidiaries or the trustees.
The AMC needs to have a minimum net worth of Rs. 50 crore.

A change in the controlling interest of the AMC can be made only with the prior approval of the trustees
and SEBI. A written communication about the change in the controlling interest of the AMC is sent to
each unit holder and an advertisement is given in one English circulation and in a newspaper published
in the language of the region where the Head Office of the mutual fund is situated. The unitholders are
given the option to exit at NAV without paying an exit load.
The AMC is responsible for conducting the activities of the mutual fund. It therefore arranges for the
requisite offices and infrastructure, engages employees, provides for the requisite software, handles
advertising and sales promotion, and interacts with regulators and various service providers.
The AMC has to take all reasonable steps and exercise due diligence to ensure that the investment of funds
pertaining to any scheme is not contrary to the provisions of the SEBI regulations and the trust deed.
Further, it has to exercise due diligence and care in all its investment decisions.
The appointment of an AMC can be terminated by a majority of the trustees, or by 75 percent of the Unit-
holders. However, any change in the AMC is subject to prior approval of SEBI and the Unit -holders.
Operations of AMCs are headed by a Managing Director, Executive Director or Chief Executive Officer.
Some of the other business-heads are:

Chief Investment Officer (CIO), who is responsible for overall investments of the fund. Fund
managers assist the CIO. As per SEBI regulations, every scheme requires a fund manager, though the
same fund manager may manage multiple schemes.
Securities Analysts support the fund managers through their research inputs. These analysts come
from two streams—Fundamental Analysis and Technical Analysis. Some mutual funds also have an
economist to analyse theeconomy.
Securities Dealers help in putting the transactions through the market. The mutual fund schemes’
sale and purchase of investments are executed by the dealers in the secondary market.
 Chief Marketing Officer (CMO), who is responsible for mobilizing money under the various
schemes. Direct Sales Team (who generally focus on large investors), Channel Managers (who manage
the distributors) and Advertising & Sales Promotion Team support the CMO.
Chief Operations Officer (COO) handles all operational issues.
Compliance Officer needs to ensure all the legal compliances. In Offer Documents of new issues,
he signs a due-diligence certificate to the effect that all regulations have been complied with, and that all
the intermediaries mentioned in the offer document have the requisite statutory registrations and
approvals.
In order to ensure independence, the Compliance Officer reports directly to the head of the AMC. Further,
he works closely with the Trustees on various compliance and regulatory issues.
AMCs are required to invest seed capital of 1percent of the amount raised subject to a maximum of Rs.50
lakh in all the growth option of the mutual fund schemes through the lifetime of the scheme.

1.3.3 OTHER SERVICE PROVIDERS:

1.3.3.1 Custodian
The custodian has custody of the assets of the fund. As part of this role, the custodian needs to
accept and give delivery of securities for the purchase and sale transactions of the various schemes of
the fund. Thus, the custodian settles all the transactions on behalf of the mutual fund schemes.
All custodians need to register with SEBI. The Custodian is appointed by the trustees. A custodial
agreement is entered into between the trustees and the custodian. The SEBI regulations provide that if
the sponsor or its associates control
50 percent or more of the shares of a custodian, or if 50 percent or more of the directors of a custodian
represent the interest of the sponsor or its associates, then, unless certain specific conditions are fulfilled,
that custodian cannot be appointed for the mutual fund operation of the sponsor or its associate or
subsidiarycompany.
An independent custodian ensures that the securities are indeed held in the scheme for the benefit
of investors – an important control aspect.
The custodian also tracks corporate actions such as dividends, bonus and rights in companies where
the fund has invested.

1.3.3.2 RTA
The RTA maintains investor records. Their offices in various centres serve as Investor Service
Centres (ISCs), which perform a useful role in handling the documentation of investors. The functions
of the RTA includes processing of purchase and redemption transactions of the investor and dealing with
the financial transactions of receiving funds for purchases and making payments for redemptions,
updating the unit capital of the scheme to reflect these transactions, updating the information in the
individual records of the investor, called folios, keeping the investor updated about the status of their
investment account and information related to the investment. The appointment of RTA is done by the
AMC. It is not compulsory to appoint a RTA. The AMC can choose to handle this activity in-house. All
RTAs need to register with SEBI.
1.3.3.3 Auditors
Auditors are responsible for the audit of accounts.
Accounts of the schemes need to be maintained independent of the accounts of the AMC.
The auditor appointed to audit the scheme accounts needs to be different from the auditor of the
AMC. While the scheme auditor is appointed by the Trustees, the AMC auditor is appointed by the
AMC.

1.3.3.4 Fund Accountants

The fund accountant performs the role of calculating the NAV, by collecting information about the
assets and liabilities of each scheme. The AMC can either handle this activity in-house, or engage a
service provider. There is no need for a registration with SEBI to perform this function.

1.3.3.5 Distributors
Distributors have a key role in selling suitable types of units to their clients i.e. the investors in the
schemes of mutual funds with whom they are empanelled. A distributor can be empanelled with more
than one mutual fund. Distributors can be individuals or institutions such as distribution companies,
broking companies and banks. Distributors need to pass the prescribed certification test, and register
with AMFI.

1.3.3.6 Collecting Bankers

The investors’ money go into the bank account of the scheme they have invested in. These bank
accounts are maintained with collection bankers who are appointed by the AMC. Leading collection
bankers make it convenient to invest in the schemes by accepting applications of investors in most of
their branches. Payment instruments against applications handed over to branches of the AMC or the
RTA need to be banked with the collecting bankers, so that the money is available for investment by the
scheme. Thus, the banks enable collection and payment of funds for the schemes. Through this kind of
a mix of constituents and specialized service providers, most mutual funds maintain high standards of
service and safety for investors.

1.3.3.7 KYC Registration Agencies

To do away with multiple KYC formalities with various intermediaries, SEBI has mandated a
unified KYC for the securities market through KYC Registration Agencies registered with SEBI. Any
new investor, Joint holders, Power of Attorney holders, Donors and Guardian (in case of minors) have
to comply with the KYC formalities. In- Person Verification (IPV) by a SEBI-registered intermediary is
compulsory for all investors. However, the investor needs to get IPV done by only one SEBI-registered
intermediary (broker, depository, mutual fund distributor etc.). This IPV will be valid for transactions
with other SEBI-registered intermediaries too.
Distributors who have a valid NISM-Series-V-A: Mutual Fund Distributors certificate and a valid
ARN can carry out the In-person verification if they have completed the KYD process.

1.3.3.8 Payment Aggregators

 Payment Aggregators such as Tech Process, Bill Desk are payment providers in the online market
place. Payment aggregators enable the users to make the payments online through their existing bank
account in a secured and a convenient manner.
Aggregators allow mutual fund houses to accept credit card and bank transfers without having to
setup a merchant account with the banks. The aggregator provides the means for facilitating payment
from the consumer via credit cards or bank transfer to the mutual fund. The mutual fund is paid by the
aggregator.

1.4 EGAL AND REGULATORY ENVIRONMENT:

1.4.1 ROLE OF REGULATORS IN INDIA:
1.4.1.1 Securities and Exchange Board of India:
Securities and Exchange Board of India (SEBI) is the regulatory authority for securities markets in
India. It regulates, among other entities, mutual funds, depositories, custodians and registrars and transfer
agents in thecountry.
The applicable guidelines for mutual funds are set out in SEBI (Mutual Funds) Regulations, 1996,
as amended till date. An updated and comprehensive list of circulars issued by SEBI can be found in the
Mutual Funds section of SEBI’s website www.sebi.gov.in. Master Circulars, which captures the essence
of various circulars issued upto a specified date, may be downloaded from www.sebi.gov.in.
Some segments of the financial markets have their own independent regulatory bodies. Wherever
applicable, mutual funds need to comply with these otherregulators also. For instance, RBI regulates the
money market and foreign exchange market in the country. Therefore, mutual funds need to comply with
RBI’s regulations regarding investment in the money market, investments outside the country,
investments from people other than Indians resident in India, remittances (inward and outward) of
foreign currency etc.

Stock Exchanges are regulated by SEBI. Every stock exchange has its own listing, trading and
margining rules. Mutual Funds need to comply with the rules of the exchanges with which they choose
to have a business relationship.
Anyone who is aggrieved by a ruling of SEBI, can file an appeal with the Securities Appellate
Tribunal (SAT).

1.4.1.2 Self-Regulatory Organizations (SRO):

In the developed world, it is common for market players to create Self- Regulatory Organizations,
whose prime responsibility is to regulate their own members. Wherever SROs exist, the statutory
regulatory bodies set up by the Government (such as SEBI in India) only lay down the broad policy
framework, and leave the micro-regulations to the SRO. For instance, the Institute of Chartered
Accountants of India (ICAI) regulates its own members.
The securities exchanges in India such as the NSE, BSE and MSEI are vested with self-regulatory
responsibilities. They regulated the firms listed on their stock exchange and also their trading members.
The Mutual Funds industry in India is in the process of getting an SRO to oversee its distributors.
 1.4.1.3 Association of Mutual Funds in India:
Asset Management Companies (AMCs) in India are members of Association of Mutual Funds in India
(AMFI), an industry body that has been created to promote the interests of the mutual funds industry
[such as the Confederation of Indian Industry (CII) for overall industry and NASSCOM for the IT/BPO
industry]. AMFI is not an SRO. The objectives of AMFI are as follows:
To define and maintain high professional and ethical standards in all areas of operation of mutual
fund industry.
To recommend and promote best business practices and code of conduct to be followed by
members and others engaged in the activities of mutual fund and asset management including agencies
connected or involved in the field of capital markets and financial services.
To interact with the Securities and Exchange Board of India (SEBI) and to represent to SEBI on
all matters concerning the mutual fund industry.
To represent to the Government, Reserve Bank of India and other bodies on all matters relating to
the mutual fund industry.
To develop a cadre of well-trained agent-distributors and to implement a programme of training
and certification for all intermediaries and others engaged in the industry.
To undertake nationwide investor awareness programme so as to promote proper understanding of
the concept and working of mutual funds.
To disseminate information on mutual fund Industry and to undertake studies and research directly
and/or in association with other bodies.

1.4.2 REGULATION OF MUTUAL FUNDS: BRIEF INTRODUCTION TO SEBI

GUIDELINES:
In 1992, the Indian Parliament passed the Securities and Exchange Board of India Act, 1992, to
establish the Securities and Exchange Board of India (SEBI) in its new incarnation as an empowered
regulator of the Indian Securities Market.
In exercise of the powers conferred by section 30 of the Securities and Exchange Board of India Act,
1992, the Board, with the previous approval of Central Government, makes regulations relating to
regulation of mutual fund.
1. Formation - Certain structural changes have also been made in the mutual fund industry, as part
of which mutual funds are required to set up asset management companies with fifty percent independent
directors, separate board of trustee companies, consisting of a minimum fifty percent of independent
trustees and to appoint independent custodians.
2. Documents - The offer documents of schemes launched by mutual funds and the scheme
particulars are required to be vetted by SEBI. A standard format for mutual fund prospectuses is being
formulated.
3. Code of advertisement - Mutual funds have been required to adhere to a code of advertisement.
4. Assurance on returns - SEBI has introduced a change in the Securities Control and Regulations
Act governing the mutual funds. Now the mutual funds were prevented from giving any assurance on
the land of returns they would be providing. However, under pressure from the mutual funds, SEBI
revised the guidelines allowing assurances on return subject to certain conditions.
5. Minimum corpus - The current SEBI guidelines on mutual funds prescribe a minimum start-up
corpus of Rs.50 crore for an open-ended scheme, and Rs.20 crore corpuses for closed-ended scheme,
failing which application money has to be refunded. The idea behind forwarding such a proposal to SEBI
is that in the past, the minimum corpus requirements have forced AMCs to solicit funds from corporate
bodies, thus reducing mutual funds into quasi-portfolio management outfits. In fact, the Association of
Mutual Funds in India (AMFI) has repeatedly appealed to the regulatory authorities for scrapping the
minimum corpus requirements.
6. Institutionalization - The efforts of SEBI have, in the last few years, been to institutionalize the
market by introducing proportionate allotment and increasing the minimum deposit amount to Rs.5000
etc. These efforts are to channel the investment of individual investors into the mutual funds.
7. Investment of funds mobilized - In November 1992, SEBI increased the time limit from six
months to nine months within which the mutual funds have to invest resources raised from the latest tax
saving schemes. The guideline was issued to protect the mutual funds from the disadvantage of investing
funds in the bullish market at very high prices and suffering from poor NAV thereafter.
8. Valuation of investment - The transparent and well understood declaration or Net Asset Values
(NAVs) of mutual fund schemes is an important issue in providing investors with information as to the
performance of the fund. SEBI has warned some mutual funds earlier of unhealthy market
9. Inspection - SEBI inspect mutual funds every year. A full SEBI inspection of all the 27 mutual
funds was proposed to be done by the March 1996 to streamline their operations and protect the
investor’s interests. Mutual funds are monitored and inspected by SEBI to ensure compliance with the
regulations.
10. Underwriting - In July 1994, SEBI permitted mutual funds to take up underwriting of primary
issues as a part of their investment activity. This step may assist the mutual funds in diversifying their
business.
11. Conduct - In September 1994, it was clarified by SEBI that mutual funds shall not offer buy back
schemes or assured returns to corporate investors. The Regulations governing Mutual Funds and Portfolio
Managers ensure transparency in their functioning.
12. Voting rights - In September 1993, mutual funds were allowed to exercise their voting rights.
Department of Company Affairs has reportedly granted mutual funds the right to vote as full-fledged
shareholders in companies where they have equity investments.
13. AMC:
The directors of the asset management company need to be persons having adequate professional
experience in finance and financial services relatedfield.
 The directors as well as key personnel of the AMC should not have been found guilty
of moral turpitude or convicted of any economic offence or violation of any securities laws.
Key personnel of the AMC should not have worked for any asset management
company or mutual fund or any intermediary during the period when its registration was
suspended or cancelled at any time by SEBI.
Prior approval of the trustees is required, before a person is appointed as director on
the board of the AMC.
14. Trustees:
Every trustee has to be a person of ability, integrity and standing.
A person who is guilty of moral turpitude cannot be appointed trustee.
A person convicted of any economic offence or violation of any securities laws cannot
be appointed as trustee.
No AMC and no director (including independent director), officer, employee of an
AMC shall be eligible to be appointed as a trustee of a mutual fund.
No person who is appointed as a trustee of a mutual fund shall be eligible to be
appointed as trustee of any other mutual fund.
Prior approval of SEBI needs to be taken, before a person is appointed as Trustee.
The trustees shall periodically review the service contracts entered into for custody
arrangements, transfer agency and others and ensure they are in the interest of the
unitholders and that all service providers are registered with SEBI.
They shall ensure that all transactions entered into by the AMC are in compliance
with the regulations and the scheme’s objectives and intent.
The trustees shall ensure that the interests of the unitholders are not compromised in
any of the AMC’s dealings with brokers, other associates and even unitholders of other
schemes.
If the trustees believe that the conduct of the business of the mutual fund is contrary
to the provisions of the regulations, then they must take corrective action and inform SEBI
of the same.
15. Custodian:
All custodians need to register with SEBI. The Custodian is appointed by the trustees.
A custodial agreement is entered into between the trustees and the custodian.
The SEBI regulations provide that if the sponsor or its associates control 50 percent
or more of the shares of a custodian, or if 50 percent or more of the directors of a custodian
represent the interest of the sponsor or its associates, then, unless certain specific conditions
 are fulfilled, that custodian cannot be appointed for the mutual fund operation of the
sponsor or its associate or subsidiary company.
16. Expense Ratio:-
All expenses incurred by a Mutual Fund AMC will have to be managed within the
limits specified under Regulation 52 of SEBI Mutual Fund Regulations.
For actively managed equity schemes, the total expense ratio (TER) allowed under
the regulations is 2.5 % for the first Rs.100 crore of average weekly net assets;
2.25 % for the next Rs.300 crore, 2 % for the subsequent Rs.300 crore and 1.75 % for the
balance AUM. For debt schemes, the expense ratio permitted is 0.25 % lower than that
allowed for equity funds. Information on expense ratio applicable to a MF scheme is
mentioned in the Scheme Information Document. For example, an expense ratio of 1% per
annum means that each year 1% of a scheme’s total assets will be used to cover the expenses
managing and operating a scheme.

In addition, mutual funds have been allowed to charge up to 30 bps more, if 30% or
more of new inflows come from locations “Beyond the Top-15 (B15) cities, to widen the
penetration of the mutual funds in tier - 2 and tier - 3 cities.
17. NAV:-Regulations ensure that schemes do not invest beyond a certain percent of their
NAVs in a single security. Some of the guidelines regarding these are given below:
No scheme can invest more than 15% of its NAV in rated debt instruments of a single
issuer. This limit may be increased to 20% with prior approval of Trustees. This restriction
is not applicable to Government securities.
No scheme can invest more than 10% of its NAV in unrated paper of a single issuer
and total investment by any scheme in unrated papers cannot exceed 25% of NAV.
No fund, under all its schemes can hold more than 10% of company’s paid up capital.
No scheme can invest more than 10% of its NAV in a single company.
If a scheme invests in another scheme of the same or different AMC, no fees will be
charged. Aggregate inter scheme investment cannot exceed 5% of net asset value of the
mutual fund.
No scheme can invest in unlisted securities of its sponsor or its group entities.
Schemes can invest in unlisted securities issued by entities other than the sponsor or
sponsor’s group. Open ended schemes can invest maximum of 5% of net assets in such
securities whereas close ended schemes can invest upto 10% of net assets in such securities.
Schemes cannot invest in listed entities belonging to the sponsor group beyond 25%
of its net assets.
 There are many other mutual fund regulations which are beyond the purview of this
module. Candidates are requested to refer to AMFI-Mutual Fund (Advisors) Module for
more information.
18. Other:-
For a mutual fund, the AMC set up should consist of 50% independent directors, a
separate board of trustees company with 50% independent trustees and independent
custodians so that some distance can be managed between fund managers, custodians, and
trustees.
As AMC manages the funds and trustees hold the custody of all the assets. A balance
must be maintained between them so that both can keep a check on each other.
SEBI takes care of the Sponsor, financial soundness of the fund and probity of the
business while granting permission.
Mutual funds must adhere to the principles of advertisement.
In the case of an open-ended scheme and closed-ended scheme, the minimum of 50
crores and 20 crores corpus is required as per the guidelines of SEBI.
A mutual fund should invest the money raised for these savings schemes within 9
months.
By this, the funds do not get invested in bullish markets and suffering from poor NAV
also reduces.
The maximum amount that a mutual fund can invest in the money market is 25% in
the first 6 months after closing the funds and 15%of the corpus after six months so that
short-term liquidity requirements can be met.
SEBI checks mutual funds every year in order to make it in compliance with the
regulations and guidelines.

1.4.3 SECURITIES AND EXCHANGE BOARD OF INDIA

(MUTUAL FUNDS) (AMENDMENT) REGULATIONS, 2020:
No. SEBI/LAD-NRO/GN/2020/07-In exercise of the powers conferred by section 30, read
with clause (c) of sub-section (2) of section 11 of the Securities and Exchange Board of India
Act, 1992 (15 of 1992), the Board hereby makes the following regulations to further amend
the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996, namely: —
1. These Regulations may be called the Securities and Exchange Board of India
(Mutual Funds) (Amendment) Regulations, 2020.
2. They shall come into force on the date of their publication in the Official Gazette.
3. In the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996, in
 regulation 26,-
i. first proviso to sub-regulation (1) shall be substituted by the
following clause, namely,-
“Provided that in case of a gold exchange traded fund scheme, the assets of the scheme being
gold or gold related instruments may be kept in the custody of a custodian registered with the
Board”.
II. In regulation 28, -

i. sub-regulation (4) shall be substituted by the following clause, namely,- “28(4). The
sponsor or asset management company shall invest not less than one percent of the amount
which would be raised in the new fund offer or fifty lakh rupees, whichever is less, and
such investment shall not be redeemed unless the scheme is wound up: Provided that the
investment by the sponsor or asset management company shall be made in such option of
the scheme, as may be specified by the Board.
 2.1 CONCEPT OF LEASING AND HIRE PURCHASE

LEASE

In simple words, a Lease is a financial contract between the business customer (user/lessee) and the
equipment supplier (normally owner/lessor) for using a particular asset/equipment over a period of
time against the periodic payments called “Lease rentals”.

The lease generally involves two parties i.e. the lessor (owner) and the lessee (user). Under this
arrangement, the lessor transfers the right to use to the lessee in return of the lease rentals agreed
upon. A lease agreement can be made flexible enough to meet the financial requirements of both
the parties.

A lease also acts as an alternative to financing business assets. There are many options for a finance
manager to choose from. He can opt for equity finance, debt finance, term loan, hire- purchase or
many others. All the means of financing differ from each other due to their different characteristics.

HIRE PURCHASE

Hire Purchase is a kind of installment purchase where the businessman (hirer) agrees to pay the cost
of the equipment in different installments over a period of time. This installment covers the principal
amount and the interest cost towards the purchase of an asset for the period the asset is utilized. The
hirer gets the possession of the asset as soon as the hire purchase agreement is signed. He becomes
the owner of the equipment after the last payment is made. The hirer has the right to terminate the
agreement anytime before taking the title or the ownership of the asset.

Hire purchase was very prominent for vehicle financing whether that is a personal car, commercial
vehicle etc but now equipment, machinery etc are also financed with hire purchase method.
 2.2 TYPES OF LEASE:

(a) Financial & Operating lease

(b) Direct lease and Sales & lease back

(c) Single investor lease and leveraged lease

(d) Domestic lease and International lease

(a) Financial & Operating lease

A lease is considered as a financial lease if the lessor intends to recover his capital outlay plus the
required rate of return on funds during the period of lease. It is a form of financing the assets under
the cover of lease transaction. A financial lease ‘is a non-cancellable contractual commitment on
the part of the lessee (the user) to make a series of payments to the lessor for the use of an asset.

In this type of leases, lessee will use and have control over the asset without holding the title to it.
The lessee acquires most of the economic values associated with the outright ownership of the asset.
The lessee is expected to pay for upkeep and maintenance of the asset. This is also known by the
name ‘capital lease’.

The essential point of this type of lease agreement is that it contains a condition whereby the lessor
agrees to transfer the title for the asset at the end of the lease period at a nominal cost. At the end of
lease it must give an option to the lessee to purchase the asset he has used at the expiry of the lease.
Under this lease usually 90% of the fair value of the asset is recovered by the lessor as lease rentals
and the lease period is 75% of the economic life of the asset.

The lease agreement is irrevocable. Practically all the risks incidental to the asset ownership and all
the benefits arising there from is transferred to the lessee who bears the cost of maintenance,
insurance and repairs. Only the title deeds remain with the lessor. The financial lease is generally
given for a long period of time.

An operating lease is similar to the financial lease in almost all aspects. This lease agreement gives
to the lessee only a limited right to use the asset. The operating lease is generally for a short-term,
where the lessor is usually the manufacturer of the asset, who want to increase his
sales by allowing the customers to pay in installments for a short-term and ultimately the title to the
asset will be transferred to the lessee on making full payment.

In some cases the lessor keeps the title to the goods and he continues to lease the asset to other party
until the life of the asset is completed. In the operating lease, it is the responsibility of the lessee to
maintain and upkeep the asset properly when the asset is under his control.

The lessor will enjoy the depreciation claim and the lessee will show his lease rentals and asset
maintenance expenses as business expenditure. At the end of the life of the asset, it will be sold off
by the lessor to get the salvage value.

(b) Direct lease and Sales & lease back

Direct Lease: The direct lease is a simple form of a lease agreement where the lessor and the lessee
are two separate entities and may have either the operating or a finance lease agreement. There can
be two types of direct lease: Bipartite Lease and the Tripartite Lease.

In a bipartite lease, there are two parties to the lease agreement; one is the lessor, and the other is
the lessee. Whereas in the case of a tripartite lease agreement, there are three parties to the
agreement, one is the supplier of the equipment; the other is the lessor, and the third one is the
lessee.

Sale and Lease Back:

Under this the lessee first purchases the equipment of his choice and then sells it to the lessor firm.
The lessor in turn leases out the asset to the same lessee. The advantage of this method is that the
lessee can satisfy himself completely regarding the quality of the asset and after possession of the
asset convert the sale into a lease arrangement.

This option he can exercise even in the case of an old asset used by him for some-time to get the
release of lump sum cash which he can put into alternative use. The lessor gets the tax credit for
depreciation. This method of financing an asset is also popular when the lessee is in liquidity
problems; he can sell the asset to a leasing company and takes it back on lease. This will improve
the liquidity position of the lessee and will continue to use the asset without parting with it.
 (c) Single investor lease and leveraged lease

The Single Investor Lease and Leveraged Lease is other types of leases classified on the basis of
a relationship between the lessee and the financier. The lease refers to the contractual agreement
wherein the lessor, the owner of the property give rights to the lessee to use his property in exchange
for periodical rental payments.

Single Investor Lease: In the case of a single investor lease there are two parties to the contract,
the lessor and the lessee. Here, the lessor or the leasing firm raises an optimum mix of debt and
equity to finance the entire investment.

One important thing to be noted here is, the lender cannot recover any amount from the lessee in
case the lessor defaults on his debt service obligations. Thus, the lender is only entitled to recover
money from the lessor and not from the lessee in case the lessor defaults in paying back to the
lender.

Leveraged Lease: In a leveraged lease, there are three parties to the lease agreement Viz. Lessor,
lessee and lender or loan participant. Here the investment is financed jointly by the lessor and the
lender; wherein the equity is arranged by the lessor, and the debt is financed by the financier. In this
kind of a lease agreement, the lender has the direct connection to the lessee which means in case
the lessor defaults in his debt obligations, the lender can recover his money from the lessee.

Hence, the major difference between the single investor lease and leveraged lease is that in the case
of the former lease type, the lender has no direct connection to the lessee and cannot recover money
from him in case the lessor defaults. Whereas in the case of the leveraged lease, the lender can
recover money from the lessee in case the lessor defaults and thus, has the direct connection to the
lessee.
 (d) Domestic lease and International lease

Definition: The Domestic Lease and International Lease is the types of leases classified on the
basis of the places where the parties to the lease agreement reside. The lease is the agreement
between the lessor and the lessee; wherein the lessor grants permission to the lessee to use his
property in return for periodical rental payments.

Domestic Lease: When all the parties to the lease agreement Viz. Lessor, lessee and the equipment
supplier are domiciled or belongs to the same country, is called as a domestic lease.

International Lease: The international lease refers to the type of lease agreement where one or
more parties to the lease agreement reside or are domiciled in different countries.

2.3 LEGAL ASPECT OF HIRE PURCHASE

The Hire Purchase System is regulated by the Hire Purchase Act 1972. Under Section 2(c) of the
Act, “Hire Purchase Agreement means an agreement under which goods are let on hire and under
which the hirer has an option to purchase them in accordance with the terms of the agreement and
includes an agreement under which:

(i) Possession of goods is delivered by the owner thereof to a person on condition that such person
pay the agreed amount in periodical instalments, and
(ii) The property in the goods is to pass to such person on the payment of the last of such
instalments, and
(iii) Such person has a right to terminate the Agreement at any time before the property so passes.”
Every Hire Purchase Agreement must be in writing and signed by all the parties thereto.

Contents of Hire Purchase Agreement:

According to Section 4 of the Act, every hire purchase agreement shall contain the following
particulars:
(a) The hire purchase price of the goods to which the agreement relates;

(b) The cash price of the goods, that is to say, the price at which the goods may be purchased
by the hirer for cash;

(c) The date on which the agreement shall be deemed to have commenced;

(d) The number of instalments by which the hire purchase price is to be paid, the amount of
cash of those instalments, and the date, or the mode of determining the date, upon which it
is payable, and the person to whom and the place where it is payable; and

(e) The goods to which the agreement relates, in the manner sufficient to identify them.